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Let's Build a Smarter [Apportionment Formula]


Although the Presidential election is over, our nation remains deeply divided – with respect to whether the Multistate Tax Compact is a binding contract, that is! A California court said in Gillette that it is; now a Michigan court says in IBM that it isn't. Which view is correct? Ultimate resolution of this issue could be worth millions of dollars in potential tax refunds for taxpayers who apportioned income to Compact states using a statutory formula that departs from the Compact's elective three-factor formula. Litigation on this issue does not appear to be slowing down and we can't help but wonder if the U.S. Supreme Court ultimately may get involved.    

The Michigan Court of Appeals held last week in International Business Machines Corp. v. Department of Treasury, No. 306618 (Mich. Ct. App. Nov. 20, 2012), that the taxpayer could not elect to use the Compact's three-factor formula to apportion its income for purposes of the Business Income Tax part of the Michigan Business Tax Act ("MBT Act"), in stark contrast to the California Gillette decision [see Gillette: "The Best a [Taxpayer] Can Get!" 10/1/2012].

In affirming the Court of Claims' grant of summary disposition, the Court of Appeals first found that the apportionment provisions in the Compact and the MBT Act are irreconcilably in conflict. Specifically, while the Compact allows taxpayers a choice between the three-factor formula and a formula provided by state statute, the MBT Act requires taxpayers to use a single-factor formula except in unusual circumstances where the taxpayer requests permission to use an alternative method of apportionment. Applying basic rules of statutory construction to resolve the irreconcilable conflict, the Court found that the MBT Act's provision controls because it was enacted later in time and is the more specific statute. According to the Court, a taxpayer may depart from the MBT Act's mandatory single-factor formula only by showing, pursuant to the MBT Act's alternative apportionment provision, that the statutory formula unfairly represents the taxpayer's business activity in Michigan. The Compact's election provision, by contrast, does not require any showing of unfair apportionment under the statutory formula.    

The Court next found that the Compact is not a binding contract and that the legislature did not clearly express an intent to surrender its taxation powers. Conceding that enactment of a conflicting apportionment statute under the MBT Act may not have been the "proper" way to repeal the applicability of the Compact to Michigan, the Court nevertheless found that the MBT Act impliedly repealed the Compact's apportionment election provision. Accordingly, in the absence of unusual circumstances, taxpayers currently are required to apportion their income under the MBT Act using a single-factor formula. We hope that the taxpayer will appeal this decision.

Looking Ahead

The courts of several states are now in conflict over whether the Compact creates a binding contract among its member states. As litigation in California and Michigan and other states continues, the United States Supreme Court may soon be presented with a compelling opportunity to determine whether the Multistate Tax Compact is a binding contract under the Contract and Compact Clauses of the United States Constitution. We remain confident that the Gillette decision was properly decided and that taxpayers should consider filing refund claims for income taxes paid to states that are full members of the MTC Compact – most of which have statutes that depart in some way from Compact provisions.  

For help determining whether to file refund claims in a particular jurisdiction, and what non-conformity issues may be appropriate for your company to include in its refund claims, contact one of the authors of this Alert.

IRS Circular 230 Disclosure: To comply with certain U.S. Treasury regulations, we inform you that, unless expressly stated otherwise, any U.S. federal tax advice contained in this communication, including attachments, was not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding any penalties that may be imposed on such taxpayer by the Internal Revenue Service. In addition, if any such tax advice is used or referred to by other parties in promoting, marketing, or recommending any partnership or other entity, investment plan, or arrangement, then (i) the advice should be construed as written in connection with the promotion or marketing by others of the transaction(s) or matter(s) addressed in this communication and (ii) the taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor. To the extent that a state taxing authority has adopted rules similar to the relevant provisions of Circular 230, use of any state tax advice contained herein is similarly limited.

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For more information, please contact the professional(s) listed below, or your regular Crowell & Moring contact.

Donald M. Griswold
Partner – Washington, D.C.
Phone: +1 202.624.2730

Jeremy Abrams
Counsel – Washington, D.C.
Phone: +1 202.624.2926